August 15, 2007

We need to repair what fear brought us last time

Sir, Martin Wolf writes that “In a world of overconfidence fear makes a welcome return” August 15, as a response to the current unknown-knowns of the market as Rumsfeld would have phrased it. Although I cannot say that I disagree with his article it brought back to my memory the first piece I ever published, titled “Puritanism in Banking” Caracas, El Universal, back in 1997, where I warned against the costs of overreacting to a bank crisis. At that time I felt that the premature adoption of some of the banking regulations pushed by the authorities in Basel had made a recent bank crisis so much worse.

The role of the credit rating agencies and that came as response to previous crisis has caused much of the market to relax its due diligence processes and is therefore something directly responsible for the runaway financing of not just subprime but absolutely wrongly awarded mortgages. Now it is obvious that we need to dismantle a system that places so much decision power in the hands of some few credit rating agencies and which undoubtedly is setting us up to systemic risk Tsunamis.

Also, instead of injecting so much liquidity why do not the Central Banks try to loosen up those capital requirements that Basel created in reaction to previous banking frights. This would of course not fuel a renewal of a subprime mortgage boom or anything like it, but allow for the recognition of the disaster to be more digestible. Summing up, ironically, what we now need is also to repair what fear brought us last time.